House prices across most of Europe are much higher than 10 years ago; to a significant extent this is likely to have been driven by higher incomes and, to a lesser extent, by rising population. Lower interest rates have been an important factor. But in many countries more favourable expectations have also probably played a big role. That factor is likely to be volatile and possibly transitory, so declines in prices are clearly possible, and in some countries quite likely.
In its 'Financial Innovation and European Housing and Mortgage Markets' report, that was published earlier this week, Morgan Stanley analyzes what types of mortgage are likely to prove more suitable in a world where prices are higher relative to incomes and where house prices may be volatile and cannot be assumed to carry on rising.
Overwhelmingly across Europe a mortgage remains a nominal contract with repayments unrelated to movements in consumer or house prices. In many countries, particularly the UK, the repayment is also very significantly affected by movements in short-term, nominal interest rates.
With indexed mortgages repayments can depend on consumer prices and also, to an extent, on house prices. Repayments are linked to real interest rates that are less variable than nominal rates. Indexed linked mortgages generate a flatter real burden of repayments over time and also a less volatile one. Right now they are offered hardly anywhere across Europe.
There are strong reasons to believe that innovation will come because indexed mortgages create financial assets that should suit investors - as well as creating very big benefits to borrowers.
Source: Morgan Stanley
Click here to read the full report.